Key points:
- Bendigo and Adelaide Bank Limited (Bendigo Bank) announced its full year results to 30 June, 2014, on Monday with a headline net profit after tax of $372m, up almost 6% from the previous year.
- Despite the solid results we believe the Bendigo Bank 29 January 2024 (callable 29 January 2019) subordinated floating rate notes (FRN) issued earlier this year have rallied strongly and are now “fully priced”.
- Investors may consider switching into higher rated, superior structure (“old style”) subordinated bonds from issuers such as National Wealth Management at similar credit margins. Alternatively, investors may consider inflation linked bonds (ILBs) such as the Sydney Airport 2020 or 2030 bonds which may provide superior performance in the current low interest rate, but relatively high inflation rate environment which benefits ILBs over FRNs.
Bendigo and Adelaide Bank Limited (Bendigo Bank) announced its full year results to 30 June, 2014, on Monday.
The full investor presentation can be viewed by clicking here
Bendigo Bank reported a solid net profit after tax of $372m, up 5.7% from a year earlier. Underlying cash earnings (which ignore one-off items) were up almost 10% on the previous year at $382m and both beat market consensus estimates.
The key features of the results were as follows:
- The bank increased its net interest margin by 5bps from 2.21% to 2.26%, a notable achievement in an increasingly competitive lending market. This was achieved with a combination of considered loan growth (6% versus system growth of 7.25% in 2H14) and cheaper funding as margins on term deposits and securitisations fell.
- Bendigo Bank in particular has been a beneficiary of lower competition in the deposit market, with approximately 80% of its total funding in the form of deposits versus around 60% for the ‘Four Majors’.
- The recently announced settlement of the disputed Great Southern managed investment scheme loans (subject to court approval) is also viewed as a positive development.
- Common equity Tier 1 ratio (CET1) improved from 7.82% to 8.73% from 30 June, 2013, to 30 June, 2014, due to $380m of equity and $300m of subordinated debt raised after the announcement of the Rural Finance Corporation of Victoria acquisition. However, with the acquisition settling on 1 July 2014 and the assets coming onto the balance sheet, the pro-forma CET1 is more accurately displayed at approximately 8.02%.
- While the bank was impacted by some large one-off bad debts, particularly in the rural/cattle farming sector in 1H14, asset quality is considered sound and well provisioned. Further, non-performing loans as measured by the percentage of loans in arrears past 90 days, is trending downwards.
Relative value summary
Overall, the solid Bendigo Bank FY14 result reflected the improving market for retail banks, particularly lower deposit and securitisation funding costs. The improvement in net interest margins and restrained loan growth, in an increasingly competitive residential home loan market, provide comfort. As does the statement made by Managing Director Mike Hirst in the results release that “we do not pursue growth for growth’s sake.”
Notwithstanding the positive result, the Bendigo Bank 29 January 2024 (callable 29 January 2019) subordinated floating rate note (FRN or bond) has rallied strongly since it was launched just over six months ago and is now considered “fully priced”.
As the chart below of credit margin on a selection of subordinated bonds demonstrates, the market has seemingly forgotten about the “old style” subordinated debt of issuers such as National Wealth Management Holdings (a wholly owned subsidiary of NAB and parent of MLC) and Vero Insurance (a wholly owned subsidiary of the Suncorp Group). The subordinated bonds of these issuers are superior to the “new style” subordinated bonds of Bendigo Bank and to a lesser extent Insurance Australia Limited (IAL), a wholly owned subsidiary of IAG Limited, across three important credit measures:
- The National Wealth Management Holdings 16 June 2026 (16 June 2016 call) and Vero Insurance 7 September 2025 (7 September 2015 call) subordinated bonds have significantly shorter time to call date than the Bendigo Bank and IAL (19 March 2019 call) subordinated bonds, assuming all are called at first opportunity. The longer the term, the greater the credit risks.
- National Wealth Management Holdings and Vero Insurance are stronger credits that Bendigo and arguably IAL.
- Both the National Wealth Management Holdings and Vero Insurance subordinated bonds are “old style” step-up securities which are superior in structure to the “new style” Basel III-complaint subordinated bonds of Bendigo Bank and IAL. The latter are exposed to non-viability clauses and are also deemed to have materially higher call risk. (For further information on the additional risk of “New style" Basel III-compliant bank subordinated bonds click here)
Given these three important factors, the “old style” subordinated bonds should be trading at a credit margin below that of the smaller, higher risk Bendigo Bank subordinated bond. The strong rally in Bendigo Bank issue and inactivity in the National Wealth Management Holdings and Vero Insurance subordinated bonds has created an opportunity to reduce risk but maintain a similar credit margin. Further, there is market chatter of further “new style” subordinated debt issuance from a regional bank in the near term which could see some funds sell out of the well performed Bendigo Bank issue into the new, higher yielding offer.
The National Wealth Management Holdings 16 June 2016 call subordinated FRN in particular looks attractive on a risk reward basis given the similar credit margin but shorter term to call and superior credit quality, as an integral component of the broader NAB Group. While the Vero Insurance subordinated bond shows a higher margin, it has just over one year to run to call date and can be difficult to source.
Alternatively, investors may consider moving to inflation linked bonds (ILBs) such as the Sydney Airport 2020 or 2030 bonds which may provide superior performance in the current low interest rate, but relatively high inflation rate, environment which benefits ILBs over FRNs. The Sydney Airport 2020s are currently offered at an indicative annual return (or yield to maturity) of 5.70% and the 2030s at 6.31% (assuming an inflation rate of 2.5%). This compares to a current annual return (to call) on the Bendigo Bank 29 January 2024 (callable 29 January 2019) subordinated bond of under 5.0%.
The National Wealth Management Holdings 16 June 2016 call and Vero Insurance 7 September 2015 call subordinated bonds are both available to retail and wholesale investors in minimum (face value) parcels sizes of $10,000.
The Sydney Airport 2020 and 2030 ILBs are also available to retail and wholesale clients in minimum (face value) parcels sizes of $13,161 and $12,346 respectively.
All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.